In fair lending terms, disparate impact is often evidenced by outcome and not intent. Disparate impacts often occur due to what seem to be neutral changes in bank policy. For example, a financial institution might decide not to make home mortgage loans of less than $75,000. Although this policy appears neutral regarding any of the prohibited bases and applies equally to everyone, this policy could be found to have a disparate impact if it can be shown to disproportionally exclude certain applicants from consideration.
Between the Equal Credit Opportunity Act and the Fair Housing Act, lending discrimination is prohibited on the following bases: race, color, religion, national origin, sex, age, marital status, familial status, disability, or receipt of public income.
Five conditions must generally exist for a policy to be considered disparate impact: 1) a specific policy must be involved, 2) the policy should be neutral regarding any of the prohibited bases, 3) the effects of the policy should fall disproportionately a prohibited basis group, 4) there should be a causal relationship between the policy and the adverse result, and 5) the policy either: a) has no clear rationale, or appear to exist merely for convenience, or does not meet industry standard underwriting considerations / lending practices, or b) there is not an equally effective alternative for accomplishing the same objective with a smaller adverse impact.
The existence of a disparate impact does not mean there is fair lending violation. When a regulator determines that the conditions exist to create a disparate impact, it is the regulator’s decision whether to pursue a violation by notifying the financial institution and soliciting their response. In submitting their response, the financial institution may justify their policy to keep the policy in place, despite the disparate impact.
Disparate impact can, however, be justified by a business necessity. Although there is not much interpretation or guidance giving in-depth discussion or explanation of what a “business necessity” is, the interagency exam procedures list the five conditions which must generally exist (1-5 listed above) as things examiners should consider when evaluating whether a policy can be justified as a “business necessity.”
Disparate impact can also by justified if it is the most effective method of accomplishing a legitimate business objective. As noted above, examiners can evaluate the policy to see if there is a less discriminatory alternative, or an equally effective policy that would cause less disparate impact, and if so, then the financial institution’s policy may constitute a violation, and the institution may need to pursue the less discriminatory alternative in such an instance.
When drafting and evaluating policies, financial institutions should always be mindful of disparate impact and the prohibited bases on which even unintended discrimination can occur. To this end, Compliance Alliance can help in this process. Our Fair Lending Toolkit has more than 20 helpful tools with some focusing on fair lending in general, such as our Fair Lending Policy template, and others focusing on specific regulations, such as our HMDA Fair Lending Analysis Worksheet, or our Section 1071 Coverage Flowchart. In addition you can submit your policies to our review team through the dashboard on our website to have us review your policy for any fair lending concerns you may have. Finally, you can always reach out to us on the hotline about any fair lending or disparate impact situations you encounter.